10 Common Legal Issues Found During Venture Capital Due Diligence (And How to Fix Them Before Investors Find Them)
This article examines ten common legal issues found during venture capital (VC) due diligence and explains how founders can address them before they become obstacles to funding.
VC legal due diligence is the process by which a VC fund and its advisers verify a company’s ownership, governance, assets, contracts, workforce, compliance and potential liabilities before investing. Problems discovered late can delay completion, increase costs, weaken the founders’ negotiating position or cause the investor to reconsider the deal.
What does VC legal due diligence involve and when should founders prepare for it?
Due diligence usually begins after the main commercial terms have been agreed, often in a term sheet. The investor’s solicitors will send a request list, and the company will provide documents and responses through a virtual data room.
The scope depends on the company and proposed investment. The findings may affect the valuation, investment documents, conditions to completion or whether the investor proceeds.
Founders should ideally prepare for VC due diligence before signing the term sheet. Historic share issues, third-party consents, intellectual property assignments and tax questions can take time to resolve, particularly in a complex or regulated business.
Start by reconciling the cap table, identifying material legal defects and preparing likely warranty disclosures. The data room should use clearly labelled folders, consistent filenames and a central index, with an accurate record of what was disclosed and when.
1. An inaccurate cap table or unclear share ownership
A cap table records who owns shares and options in the company and enables investors to calculate ownership and dilution following the funding round. Problems arise when it conflicts with the register of members, option register, Companies House filings or supporting documents.
Common issues include shares promised but never recorded, unregistered transfers, undocumented nominee arrangements and inconsistent versions of the cap table. The register of members remains the company’s principal legal record of share ownership, so a spreadsheet alone is not sufficient.
How to fix it
Reconcile the ownership records. Compare the register of members and option register with the cap table, share certificates, transfer forms and Companies House filings. Record and investigate every inconsistency.
Verify and correct each transaction. Establish what was agreed and whether each allotment or transfer took legal effect. Obtain missing documents or take legal advice on any necessary approvals, rectification or agreement with an affected shareholder.
2. Defective share allotments and missing approvals
An accurate cap table does not prove that the underlying shares were validly issued. The directors must have authority to allot the shares, applicable pre-emption rights must be addressed, and the necessary board, shareholder and investor approvals must be obtained.
Common problems include missing resolutions, unsigned subscription documents, incorrect share classes and informal rights recorded in emails or side letters. Historic anti-dilution protection, preferential returns or consent rights may also affect the proposed funding round.
How to fix it
Review each historic share issue. Check the allotment against the articles, shareholders’ agreement, investment documents and approvals in force at the time. Confirm that the necessary authority, pre-emption procedure and any required consents were properly addressed.
Resolve defects and conflicting rights. Identify any voting, transfer, consent or preferential rights affecting the new investment. Remedial action may involve ratification, replacement documents, shareholder resolutions, Companies House filings or agreement with an affected shareholder.
3. The company does not own its intellectual property
Intellectual property may be a technology or knowledge-based company’s most valuable asset. Investors will therefore check whether the company owns, or has adequate rights to use, its software, source code, brand, designs, inventions, databases, domain names and content.
Problems commonly arise where intellectual property was created before incorporation or by a founder, freelancer, consultant, agency or developer. Paying a contractor does not automatically transfer ownership, and without an effective written assignment the company may have only limited or implied rights. Open-source software, third-party licences and unregistered trademarks may create additional risks.
How to fix it
Map the company’s intellectual property. Identify each material asset, its creator and current owner, together with the documents supporting ownership or use. Include registered rights, licensed technology and material open-source components.
Review the underlying agreements. Check employment, founder, contractor and developer agreements for suitable intellectual property and confidentiality provisions. Obtain correctly executed assignments where ownership has not passed to the company.
Protect key rights. Consider registering important trademarks or designs and document the use of third-party and open-source materials. Confirm that relevant licence terms permit the company’s current activities and planned growth.
4. Weak founder arrangements and no vesting protection
Investors will examine what happens if a founder leaves, stops contributing or falls into dispute with the other shareholders. Where founder shares were issued without vesting or leaver provisions, a departing founder may retain a substantial stake despite no longer working in the business.
This “dead equity” allows the former founder to benefit from value created by the remaining team and may reduce the equity available for future recruits or investors. A VC investor may therefore request reverse vesting and good leaver or bad leaver provisions, which can determine whether shares must be transferred and at what price.
How to fix it
Review the founder documents. Check the articles, shareholders’ agreement, service agreements and any informal commitments. Establish what currently happens to a founder’s shares if they leave or stop contributing.
Agree vesting and leaver terms. Address the vesting period, credit for time served, resignation, dismissal, illness and incapacity. Specify when shares must be transferred, how many are affected and the applicable price.
Negotiate the personal consequences. The provisions should be clear, proportionate and commercially workable. Founders should take advice rather than accept an investor’s standard drafting without review.
5. Missing or unsuitable employment and consultancy agreements
Investors will check whether key personnel are properly engaged and whether the company has protected its intellectual property, confidential information and customer relationships. Common concerns include outdated or unsigned contracts, informal consultancy arrangements, missing confidentiality provisions and restrictive covenants that may be too broad to enforce.
Contractors may also have worker or employee status despite being described as self-employed. Misclassification can create liabilities involving holiday pay, minimum wage, PAYE, National Insurance contributions and statutory employment rights.
How to fix it
Audit the workforce. Confirm each person’s role, employment status, remuneration and governing agreement. Identify missing documents and arrangements that do not reflect working practices.
Update the contracts. Put appropriate signed agreements in place covering duties, pay, termination, confidentiality and intellectual property. Ensure the terms reflect how each relationship operates in practice.
Review key risks. Investigate uncertain employment status and check that restrictive covenants are proportionate to the individual’s role. Obtain employment or tax advice where potential misclassification or historic liabilities are identified.
6. Informal, undocumented or non-compliant share options
Informal equity promises can create uncertainty about the number of shares offered, vesting terms and whether a percentage is calculated before or after fundraising. Investors will also check that options were properly approved, documented and recorded, and that the company has sufficient authority and shares to satisfy them.
EMI options require additional tax compliance. For options granted on or after 6 April 2024, the grant must currently be notified to HMRC by 6 July following the end of the tax year in which it was made, while missed notification or reporting deadlines may put the expected tax treatment at risk. Although the principal company-level EMI limits were expanded from 6 April 2026, the detailed eligibility conditions still apply.
How to fix it
Reconcile the option records. Compare all equity promises, option agreements, board approvals and vesting schedules with the option register and fully diluted cap table. Identify any undocumented or inconsistent awards.
Check EMI compliance. Review the company’s eligibility, valuations, grant documents and HMRC submissions. Confirm that all applicable notification and annual reporting requirements have been met.
Take advice before correcting defects. Do not cancel, vary or regrant an option without considering the legal and tax consequences. An attempted correction may alter the option holder’s expected treatment or create further compliance issues.
7. Material contracts contain unexpected risks
Investors will review contracts supporting the company’s revenue, technology and operations, including key customer, supplier, licensing and distribution agreements. They will assess whether revenue is genuinely recurring and whether important contracts can be terminated or become more expensive following the investment.
Common risks include change-of-control consents, uncapped liability, broad indemnities, exclusivity obligations, restrictions on pricing or expansion, and informal variations that differ from the signed terms. Any of these may affect the company’s valuation, business plan or investment documents.
How to fix it
Prioritise material contracts. Rank agreements by value, strategic importance and legal risk. Focus first on contracts supporting significant revenue, essential technology or critical supply arrangements.
Identify problematic terms. Record termination and renewal dates, change-of-control provisions, consent requirements, liability exposure and restrictions on growth. Compare the signed terms with how each relationship operates in practice.
Plan any remedial action. Consider whether the issue requires disclosure, renegotiation, consent or additional contractual protection. Do not approach a counterparty before assessing whether the request could reveal the funding round or prompt demands for revised terms.
8. Data protection and regulatory compliance gaps
Investors will check whether the company complies with the UK GDPR, the Data Protection Act 2018 and any sector-specific regulation. Common concerns include outdated privacy notices, missing processor terms, undocumented international transfers, inadequate security procedures and no process for managing data requests or breaches.
Depending on the business, due diligence may also cover financial services permissions, consumer law, advertising, product safety, export controls, sanctions or environmental obligations. A missing authorisation or untested regulatory assumption may place the company’s business model at risk.
How to fix it
Map the applicable requirements. Identify what personal data the company uses, where it is stored and which suppliers receive it. Confirm which wider regulatory regimes, permissions or licences apply to the company’s actual activities.
Address priority gaps. Update key policies, notices, processor contracts, transfer arrangements and incident-response procedures. Give immediate attention to any missing authorisation or compliance issue that could prevent the business from operating lawfully.
Document ongoing remediation. Record significant compliance decisions and any corrective work that cannot be completed before the investment. Disclose material gaps transparently and agree a realistic post-completion plan where necessary.
9. SEIS, EIS and tax-related investment problems
SEIS and EIS tax relief can be important to angel investors, but HMRC advance assurance does not guarantee that every investor or share issue will qualify. The company must still submit the relevant compliance statement and continue meeting the applicable conditions.
Relief may be affected by historic share issues, preferential rights, group structures, non-qualifying activities or the use of investment funds. Information given to HMRC must also remain consistent with the company’s documents and activities.
How to fix it
Review the company’s history. Check previous share issues, advance assurance applications, compliance statements, investor certificates and use of funds. Identify any inconsistency with the company’s current structure or activities.
Check the proposed investment. Confirm that the share rights, investment documents and intended use of funds reflect specialist tax advice. Address potential eligibility issues before shares are issued.
Avoid guaranteeing relief. Explain that qualification depends on continuing conditions and, in some cases, the investor’s circumstances. The investment documents should allocate this risk appropriately rather than promise that relief will be available.
10. Undisclosed disputes and contingent liabilities
Investors will examine current, threatened and historic disputes, including employment grievances, customer complaints, intellectual property allegations, tax enquiries and regulatory correspondence. Even a seemingly minor claim may reveal wider legal, financial or reputational risk.
Late or incomplete disclosure can also undermine investor confidence and increase the risk of a warranty claim after completion. The disclosure letter should therefore clearly identify matters that qualify the contractual warranties.
How to fix it
Identify potential claims. Review complaints, demands, grievances and regulatory correspondence, including matters that have not reached formal proceedings. Gather the relevant documents and establish the current position.
Assess the exposure. Work with the company’s solicitors to evaluate the legal, financial and reputational risk. Preserve legal privilege and avoid making unnecessary admissions during the review.
Prepare clear disclosure. Disclose matters qualifying the warranties accurately and in sufficient detail. Where a dispute remains unresolved, explain its status and any proposed mitigation or settlement strategy.
What happens when due diligence finds a legal problem?
Most issues will not automatically end the funding round. The outcome usually depends on the seriousness of the risk, whether it can be fixed and how promptly the founders disclosed it.
Possible consequences include:
Remediation or additional protection. The investor may require documents, consents or corrected records before completion, or impose post-completion undertakings. It may also seek warranties or a specific indemnity where the risk cannot be removed.
Commercial renegotiation. A significant issue may affect the valuation, investment amount, founder vesting or investor control. The parties’ options will depend partly on the term sheet and which provisions are legally binding.
Withdrawal from the investment. Fraud, disputed ownership of core intellectual property or serious regulatory breaches may cause the investor to walk away. Early disclosure supported by a credible remediation plan will usually place the company in a stronger position.
How The Jonathan Lea Network can help
The Jonathan Lea Network advises founders, companies and investors on venture capital and angel investment rounds, from investment-readiness reviews through to negotiation and completion. We can review corporate records, correct historic defects, prepare intellectual property and workforce documentation, review material contracts and implement share option arrangements.
We can also prepare and negotiate the investment agreement, shareholders’ agreement, articles of association, disclosure letter and completion documents. If you have received a term sheet or due diligence request list, contact us with the proposed investment, target completion date and principal corporate documents so that we can identify the priorities and propose a proportionate scope of work.
Contact Us
We will respond to most enquiries with both an indicative scope of work and fee estimate, as well as the offer of a complimentary 20-minute discovery video call to discuss your issues and how we can help, before sending a more considered formal fee estimate via email.
In some limited cases, if you would just like initial advice and guidance on a call, we may instead offer a fixed fee appointment (commonly charged between £280 to £500 + VAT) whereby we will review the information you provide, hold a video call consultation and then follow up with an advisory email (as well as a fee estimate for any further work identified)
Please email wewillhelp@jonathanlea.net or call us on 01444 708640 as a first step. We will first need to receive an overview of the background and your issues, together with any significant documents, in order to provide an indicative scope of work and fee estimate
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This article is intended for general information only, applies to the law at the time of publication, is not specific to the facts of your case and is not intended to be a replacement for legal advice. It is recommended that specific professional advice is sought before relying on any of the information given. © Jonathan Lea Limited.